There has to be a good reason to keep euro leaders at their desks in the holiday month of August – this year there isLess than two weeks ago the leaders of the eurozone were looking forward to an August sunning themselves on the beach after concluding a deal that was supposed to resolve once and for all the debt crisis on the fringes of the single currency.
Now the euphoria seems a distant memory, redolent of Neville Chamberlain's "peace in our time" as the financial markets threaten two of the big beasts of monetary union – Italy and Spain.When the heads of the 17 eurozone governments met in Brussels on July 21, they agreed not just to bail out Greece for a second time but to put together a war chest that would enable them to take pre-emptive action in countries seen as vulnerable to attack. The message to the markets was clear: monetary union will be protected come what may, so think twice before turning on Italy and Spain.
But it did not take long for the financial markets to unpick the Brussels agreement. They quickly discovered that while there was the promise of more money for the European Financial Stability Facility, it would take months for the funds to arrive, and then only if national parliaments agreed to pony up the cash. What looked on the surface a once-and-for-all solution was exposed as a naked attempt to buy time.
Events in the United States over the past week mean the respite has been short. The threat that even the world's biggest economy might welsh on its debts has reignited concerns about the weaker members of the single currency. Dismal growth figures from the US have made matters worse, since the chances of countries like Spain and Italy growing their way out of trouble will be impaired if the recovery in the global economy stalls. That now looks much more probable than it did a fortnight ago.
Nick Parsons, head of strategy at National Australia Bank, said: "Europe's leaders probably thought they had bought themselves three months. I thought they would get six weeks at best. It now doesn't look as if they will get as long as that.
"There is a growing sense of crisis enveloping markets in the northern hemisphere. Thus far asset markets in Asia have been holding up relatively well and currencies have moved in an orderly fashion. With increasing doubts about the forward momentum of the global economy, we will need to watch these Asian markets very closely for any signs of contagion. The month of August has got off to a very nervous start."In their different ways, Italy and Spain exemplify the difficulties in making the eurozone work. Deprived of the ability to devalue its currency, Italy has struggled to remain competitive with Germany and growth has been sluggish. Spain, by contrast, had excessively strong growth in all the wrong parts of the economy courtesy of a one-size-fits-all interest rate. Cheap borrowing costs led to soaring asset prices, an unsustainable construction boom and a widening current account deficit.
Bond markets are now flashing warning signs about both countries. As Europe's sovereign debt crisis has unfolded over the past 15 months, markets have sensed a country is in trouble when the yield (interest rate) on its 10-year bonds has risen above 6%. The trigger for a bailout has been when yields have topped 7%. In Spain, the peak for yields yesterday was 6.45%; in Italy it was 6.14%."We are on the brink of a major sovereign debt crisis," said Danny Gabay, of Fathom Consulting. He added that there were similarities between Europe in the summer of 2011 and the US mortgage meltdown four years ago. Greece and Portugal were akin to America's sub-prime borrowers, who were the first to run into problem, but subsequently the crisis spread to borrowers with slightly better prospects. In the context of Europe, that was Italy and Spain, with Italy's national debt of 130% of GDP making it a more pressing problem.
Servicing that debt is impossible when growth is low and interest rates are 6%-plus and rising, which is why markets are now wondering how long it will be before Silvio Berlusconi's government seeks help from the EU and the International Monetary Fund.
Jerry del Messier, the co-head of Barclays Capital, the investment banking arm of Barclays, urged European policy makers to act quickly: "Markets don't always get it right, particularly in the summer months, when volumes are low and there is a temporary loss of confidence. We need a much more engaged response."
With talks between Italy and the euro group planned for Wednesday, David Owen, managing director at Jefferies Fixed Income said there were a number of key events in the coming days that could bring the crisis to a head - including a Spanish bond auction on Thursday and the release of data for Italian growth and US jobs on Friday.The suspicion in the markets is that Zapatero's three-week holiday could turn into a weekend break. At best.